Norges Bank Review 24 September 2015 A 25bp rate cut and an easing bias Frank Jullum Chief Analyst fju@danskebank.dk www.danskebank.com/research Arne Lohmann Rasmussen Chief Analyst klom@danskebank.dk Kristoffer Kjær Lomholt Analyst klom@danskebank.dk Investment Research Important disclosures and certifications are contained from page 10 of this report.
Main points: As we expected, Norges Bank this morning decided to cut the sight deposit rate by 25bp. The revised rate path, however, was even more dovish than what we had anticipated suggesting a high likelihood of another cut. The revised rate path has a 64% implied probability of another 25bp rate cut on a 12M horizon. The rate path, however, also suggests that the sight deposit rate will not be lowered further in 2015. Market reaction: Prior to the decision markets had not expected a rate cut with only c.7-8bp priced in. Post the decision markets now price in roughly 14bp accumulated for Q4 and c. 27bp on a 12M horizon, i.e. markets don t believe that today s rate cut will for certain be the last in 2015 and that rates eventually will be lowered further. Our expectation: Based on our own above-consensus view on the oil price and hence the domestic economy, we actually expect NB to be on hold throughout 2016, and the first hike to be delivered in early 2017. We do, however, acknowledge that we will need to see a bottoming in the Regional Network Survey outlook score for Norges Bank s GDP forecast to hold. If this is not the case we could see another cut, even likely before NB projects. FX: the NOK has weakened slightly more than expected as a result of the softer-than-expected rhetoric. Shortterm relative rates and the risk premium in NOK will cap the NOK upside potential. Long-term the NOK remains significantly undervalued and we should see a stronger NOK when the business cycle turns. We maintain our forecasts for EUR/NOK at 9.40 in1m, 9.40 in 3M, 9.25 in 6M and 8.80 in 12M. Fixed Income: We still see some value left in the Norwegian government curve given the significant underperformance seen over the last month, which has not fully been reversed today. The front FRAs seems fairly priced from a strategic view, but still possible to price in more easing. 2
A 25bp cut and a very dovish bias Governor Olsen cuts the sight deposit rate by 25bp Today Norges Bank decided to cut the sight deposit rate by 25bp to 0.75% At the same meeting the revised rate path suggests an implied probability of 64% for another rate cut before Q3 2016 but also that the bank expects to leave rates unchanged at 0.75% in Q4 15. In the monetary policy statement it was stated that: The current outlook for the Norwegian economy suggests that the key policy rate may be reduced further in the coming year Our projection is very much in line with Norges Bank The revised rate path is very much in line with our own view, but if our above-consensus view for domestic growth in 2016H1 materialises, 0.75 % will actually be the bottom for Norwegian rates. We do, however, acknowledge that we will need to see a bottoming in the Regional Network Survey outlook score for Norges Bank s GDP forecast to hold. If this is not the case we could see another cut likely earlier than what NB projects. Market reaction: prior to the decision markets had not expected a rate cut with only c.7-8bp priced in. Post the decision markets now price in roughly 14bp accumulated for Q4 and c. 27bp on a 12M horizon. I.e. markets don t believe that today s rate cut will for certain be the last in 2015 and that rates eventually will be lowered further. Revised rate path indicates a 68 % probability of a rate cut Source: Norges Bank, Danske Bank Markets Post the decision markets now price in an additional rate cut on a 12M horizon 1.20% 1.00% 0.80% 0.75% 0.60% 0.40% 0.20% -14 0.00% Sep15 Dec15 Mar16 Jun16 *Estimated from stripped FRAs / indicate Norges Bank's planned rate decisions 24/09/2015 11:14 Source: Danske Bank Markets Norges Bank Pricing* -23-27 3
Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Jun-17 Aug-17 Oct-17 Dec-17 Feb-18 Apr-18 Jun-18 Aug-18 Oct-18 Dec-18 Downwards revision to rate path driven by domestic demand Arguments : NB points to a weakened outlook for the economy and the recent drop in the oil price as the main factors. The growth rates were adjusted downwards by 0.25 pp. in 2016 and 2017. A softer global outlook and lower global rates are pushing in the same direction. The depreciation of the NOK and higher inflation are pulling in the opposite direction, but not enough to hinder a cut in rates. The weakness of the NOK is resulting in higher inflation, but that is considered to be temporary. Contributing factors: "Demand" is lowering the rate path 70bp in 2016 alone. Prices, FX-developments are pushing the rate path higher (27bp in 2016), Foreign rates are also adding some downside (9bp in 2016). Wage growth is lowered by 0.25%-point in 2016 and 2017 to 2.75% and 3.25%. Rate path significantly lowered 0.80 0.60 0.40 0.20 0.00-0.20-0.40-0.60-0.80-1.00-1.20 Source: Danske Bank Markets... primarily dragged lower by the domestic demand outlook Source: Danske Bank Markets Revised rate path with contributing factors Demand Prices Foreign interest rates Exchange rate Sum Demand Prices Foreign interest Exchange rate Sum 31/12/2015-44 25-2 13-8 31/03/2016-58 29-4 19-14 30/06/2016-67 29-7 21-24 30/09/2016-76 27-10 30-29 31/12/2016-78 23-13 37-31 31/03/2017-79 18-15 42-34 30/06/2017-76 11-17 43-39 30/09/2017-73 8-19 40-44 31/12/2017-68 5-21 33-51 31/03/2018-62 2-22 25-57 30/06/2018-56 0-23 17-62 30/09/2018-50 0-24 9-65 31/12/2018-43 0-23 2-64 4
Growth forecast lowered Growth forecast cut as expected Mainland-growth was adjusted downwards by 0.25 pp. in 2016 and 2017, to 1.25 % y/y and 2.0 % y/y respectively. The main factor behind the adjustment is of course lower oil investments.. GDP forecasts lowered... Note that Norges Bank lowered its projection for the petroleum investments: By 5.0pp in 2016 By 2.5pp in 2017 By 2.5pp in 2018 For 2015 the projection was raised 2.5pp to -12.50% Y/Y which is in accordance with the latest oil investment survey. Source: Norges Bank, Macrobond, Danske Bank Markets... partly driven by downwards revision to oil investments Source: Norges Bank, Macrobond, Danske Bank Markets 5
Inflation forecast raised Inflation forecast raised for 2015 and 2016 Inflation projections raised Core inflation projections were lifted by 0.50pp in 2015, 0.50pp in 2016 and 0.25 in 2017. Wage growth is lowered by 0.25pp in 2016 and 2017 to 2.75% and 3.25%, respectively. We agree with Norges Bank Importantly, Norges Bank seems to agree with our view that inflation is a temporary problem and that wage growth is the important issue here : "The krone depreciation has pushed up consumer price inflation. Low wage growth is keeping down cost growth, and inflation will edge down as the effects of the krone depreciation unwind." Source: Norges Bank, Danske Bank Markets Wage projections lowered Source: Macrobond Financial, Danske Bank Markets 6
Norges Bank lifts I-44 forecast profile Relative rates to weigh further on the NOK As expected Norges Bank lifted its forecast for the import weighted NOK index (i.e. NB has shifted the NOK profile to a weaker level). As the chart in the margin shows NB has in the last year persistently shifted the profile higher amid the collapse in the oil price and the deterioration in economic growth outlook. In the MPR Norges Bank argued that: The krone has been weaker than developments in the interest rate differential against other countries alone would suggest. Besides weakening growth prospects, the oil price decline may have increased market participants uncertainty regarding the outlook for the Norwegian economy and interest rate developments. This may have contributed to a somewhat higher risk premium for NOK than expected in June. Indeed this is exactly what we have observed in our Microstructure model on FX flows as shown in the Norges Bank Preview. As shown on slide 4 the weaker NOK significantly lifted the rate path. Meanwhile NB still expect a gradually stronger NOK. Noteworthy, however, the revised I44 projection implies a slower appreciation of the NOK than previously pencilled in by Norges Bank (see chart to the right). Norges Bank significantly lifts I44 forecast... And now expect a slower NOK appreciation *The I44 is the NOK index that Norges Bank forecasts, and currently the EUR (34%), SEK (13%), CNY (10%), GBP (7%), DKK (6%) and USD (6%) make up the majority of the index. Source: Macrobond Financial, Danske Bank Markets 7
FX implications for EUR/NOK EUR/NOK short-term higher, then lower EUR/NOK initially spiked c. 15 figures higher on the decision to cut the sight deposit rate. This was in line with our call in the Norges Bank preview. However, when markets digested the softer-rhetoric than what we had anticipated the spot moved an additional 5 figures higher, which in our view is fair. The NOK remains fundamentally very cheap... Going forward we expect the NOK to remain weak as the liquidity premium is likely to continue to weigh on the NOK. Especially, as markets had not priced in today s rate cut the continued uncertainty as to Norges Bank monetary policy and the low oil price which were the initial drivers in widening the risk premium. With respect to the oil price, the NOK-sensitivity has fallen from record high levels in recent weeks. In the short-term we see limited upside to the oil price as global growth concerns in our view likely will continue to cap the upside potential in the oil price. Source: Bloomberg, Danske Bank Markets... but we still expect EUR/NOK to trade at elevated levels in the coming months From most fundamental perspectives, however, the NOK remains very cheap which together with stretched speculative positioning should become a NOK positive when the business cycle turns, Norges Bank has finished cutting rates and the oil price moves higher on improved global growth and lower global supply. Also, we expect ECB QE to remain a EUR negative also on a 12M horizon as we expect ECB to prolong the QE programme post September 2016. We maintain our forecast for EUR/NOK at 9.40 in 1M, 9.40 in 3M, 9.25 in 6M and 8.80 in 12M. Source: Norges Bank, Danske Bank Markets 8
Fixed Income implications We still like to be long NGBs in the mid-segment vs Germany We saw a strong rally in NOK rates after the rate cut and the dovish stance. The market is pricing roughly 14bp accumulated for Q4 and slightly above 25bp accumulated on a 12M horizon. Hence, the FRA- curve now seems fairly priced from a strategic view. But given that Norges Bank still expects positive growth in Q3 and Q4 of around 0.2% q/q growth could still surprise on the downside and the market might be able to price in a higher probability of a December rate cut. Before the meeting we recommended to buy the midsegment of the NGB-curve against bunds and to receive NOK 2y2y swap. These trades have performed well today, but still we still see some value left in the Norwegian curve given the significant underperformance seen over the last month, which has not fully been reversed today. The Norwegian forward curve is now above the Norges bank rate path underlining that value is found in the mid segment of the curve Still value in the mid-segment of the NGB curve Source: Danske Bank Markets The forward curve relative to Norges Bank rate path Source: Macrobond Financial, Danske Bank Markets, Norges Bank 9
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